Alpha, Beta, And Smart Beta Models For Advanced Crypto Trading

Insights
• Jun 13, 2024
Alpha, Beta, And Smart Beta Models For Advanced Crypto Trading

As you may know, institutional investors adopt more advanced trading strategies based on predetermined parameters and systematic models. Commonly, hedge fund managers aim to outperform the referred index, obtaining a higher return than the overall market performance. At Trakx, our mission is to empower both institutional and retail investors with the most advanced crypto trading strategies, such as Alpha, Beta, and Smart Beta crypto baskets, creating a fairer, accessible, and democratic industry. How do these sophisticated models work?

Alpha, Beta, and Smart Beta models are advanced crypto trading strategies that aim to outperform the market and/or reduce volatility and risk while effectively seizing opportunities. These models are based on fundamental and technical analysis, systematic trading, and advanced algorithms and are commonly used by the most sophisticated financial institutions. Now, all types of investors can use these advanced strategies through our Crypto Tradable Indices (proprietary crypto baskets). And that's not all. With Trakx Solutions, you can use our Index Manager Tool to create custom crypto baskets and advanced crypto trading strategies.

Advanced Crypto Trading Strategies: Alpha, Beta, and Smart Beta Models

To improve your trading strategy, you should learn about the advanced crypto trading strategies implemented by the most profitable hedge funds. So, let's start!

(α) Positive Alpha Model - Active & Risky Crypto Trading Strategy

In traditional financial markets,  Alpha (α) is a common indicator to evaluate the portfolio manager's ability to outperform a benchmark index. If Alpha is positive, it means that the fund manager beat the benchmark; if it's negative, its fund performed worse than the benchmark. In brief, Alpha is the difference between the fund manager's portfolio and benchmark returns. The simplified formula is:

Alpha = Portfolio Return - Benchmark Return

Let's make an example related to cryptocurrency. Assume you want to outperform a benchmark like the Top 10 Crypto Index (that performed +106,4% in 2023) by manually selecting some specific cryptocurrencies based on fundamental and technical analysis or thematic diversification. On January 1, 2023, you invested in a Top 10 PoS crypto basket that performed a return of 127,3% during 2023. In our example, using the simplified formula:

Alpha = (Portfolio Return (127,3%) - Top 10 Crypto Return (106,4%)/100= 20,9%.

It shows that the custom portfolio performed better than the benchmark index. If the Alpha was negative, the portfolio performed worse than the benchmark.

In cryptocurrencies, you can try to obtain a higher Alpha by actively selecting assets, aiming to outperform a benchmark index. Implementing this strategy is not easy, considering that 70% of retail traders are at a loss and that only a small minority of hedge funds consistently outperform market benchmarks over the years. However, at Trakx, we've implemented this strategy in our wide range of thematic Crypto Tradable Indices, making it easy both for institutional and retail investors to try outperforming the market by focusing on specific segments of the crypto market. For example, as shown in our previous example, the Top 10 PoS outperformed the Top 10 Crypto during 2023. However, this is possible only thanks to our Index Manager Tool, which, through advanced algorithms, automatically rebalances the crypto baskets once a month based on predefined parameters, allowing sound risk management, systematic investments, and advanced diversification.

(β) Negative Beta Model - Passive & Conservative Trading Strategy

Alpha focuses on higher returns compared to the benchmark, while Beta (β) is an indicator that shows the portfolio's volatility compared to a benchmark. Investors focusing on negative Beta aim to maintain a lower portfolio's volatility than the benchmark index. Volatility is an important factor in cryptocurrency, so focusing on negative Beta can help reduce it and consequently reduce underlying risks while still capturing the potential of the market. The math formula is:

β = Covariance (Portfolio, Bitcoin)​ / Variance (Bitcoin)

If Beta >1 : Higher volatility than the benchmark
If Beta = 1 : Same volatility
If Beta < 1 : Lower volatility
If Beta < 0 : Inversely correlated

Let's clarify with an example why some investors focus on negative Beta strategies in cryptocurrencies. Some cautious institutional investors may think that Bitcoin is too volatile and risky and want to implement a conservative approach to cryptocurrencies. So, let's consider our Digital Inflation Hedge CTI (composed of BTC 33.3%, Pax Gold 33.3%, and USDc 33.3%) and Bitcoin as a benchmark.

Assume Bitcoin, the benchmark, decreases by -20% over a given period. The Digital Inflation Hedge, assuming a 20% drop in Bitcoin, 2% rise in PaxGold, and 0% in USDc, would perform: (0.33×-20%)+(0.33×2%)+(0.33×0%)=5.59%. In this case, Beta=0,2795, meaning that the Digital Inflation Hedge CTI has lower volatility than Bitcoin.

Strategies based on negative Beta models are particularly suitable for conservative investors since they have lower volatility and risks. The Digital Inflation Hedge CTI is a good way to gain moderate exposure to Bitcoin while also capturing gold's potential, investing in 2 of the safe havens with the most potential.

Smart Beta Models: Automatic & Systematic Investing

In recent years, Smart Beta investing strategies have emerged in traditional finance. Smart Beta models are based on systematic management and aim to outperformbenchmarks using alternative weighting and rebalancing methods while improving diversification and reducing risks. The most advanced strategies based on Smart Beta models are value-based (investing in undervalued cryptocurrencies), momentum-based (dynamically investing in cryptocurrencies that have shown strong performance in the last period), and more. At Trakx, we have implemented some of these models in our Crypto Tradable Indices. Let's explore how our Recovery CTI works to understand better what it means to implement a Smart Beta strategy with our Index Manager Tool.

Recovery Crypto Tradable Index: Smart Beta Investing in Crypto

The Trakx Recovery CTI is a great example of a Smart Beta investing strategy. The crypto basket is designed to replicate the performance of a basket of 10 tokens that have undergone notable price drops but have robust potentialities. Our Index Manager Tool automatically selects the tokens with a lower P/F ratio and the highest drawdown ratio over the last 12 months, weighting the basket proportionally to the drawdown with a 15% cap.

As you can understand, it's very difficult to implement such a strategy by selecting the cryptocurrencies and periodically rebalancing the portfolio effectively. But our Index Manager Tool does it for us, allowing us to implement sound risk management while seeking to outperform the crypto markets' benchmarks. Since its launch on October 31, 2024, the Recovery CTI is currently performing around +80% and has reached an all-time high of around +197%.

Recovery CTI - Crypto Index Fund - Trakx - Advanced Crypto Trading Strategies

Trakx Solutions: Use our Index Manager Tool to Create Custom Crypto Baskets

As we recently announced in Trakx Solutions, we're happy to provide the infrastructure and knowledge to partner with financial institutions and businesses to create your own non-discretionary crypto trading strategy.

What do Trakx Solutions offer?

Trakx Solutions allows our partners to create customized crypto index funds and make them tradable natively 24/7 using our in-house proprietary and scalable technology. Our team can create new crypto index funds in a matter of hours, and we're now offering our solutions to institutional investors, businesses, and influencers. How to start with Trakx Solutions?

  1. Choose the components of the Crypto Tradable Index: Each crypto basket can be composed of multiple assets, and based on the strategy and risk profile, you can select the cryptocurrencies you prefer.
  2. Decide the weighting model: You can choose between various static and dynamic weighting models. For example, you may opt for equal weighting, market cap weighting, or more.
  3. Define the rebalancing method: Most of our crypto baskets are rebalanced on the last day of each month, but some of the most advanced, based on Smart Beta strategies, implement dynamic approaches.

That's not all because we offer customized solutions for quantitative firms that implement advanced Smart beta models and quantitative trading strategies. For example, in our recent partnership with Martial Eagle, we recreated their own strategy by copying the NAV through API. In every partnership and collaboration, we give the opportunity to keep the crypto index fund reserved only for your customers or to make it publicly accessible and tradable on our platform.

Benefits of Alpha, Beta, and Smart Beta Models in Crypto Tradable Indices

The adoption of Alpha, Beta, and Smart Beta models in crypto trading offers several broader benefits for both institutional and retail investors:

  • Accessibility: Advanced trading strategies, once reserved for sophisticated financial institutions, are now accessible to a wider range of investors through our platform. This democratization allows more people to benefit from cutting-edge investment techniques.
  • Transparency: Systematic models, particularly Smart Beta, provide transparency in investment decisions and portfolio management. Investors can understand the criteria and factors driving their investments.
  • Customization: With our Index Manager Tool, investors can create custom crypto baskets tailored to their specific thematic preferences, risk profiles, and investment goals, providing a high degree of personalization.
  • Enhanced Risk Management: By employing diversified and systematic approaches, these models help manage and mitigate risks, offering more stable and resilient investment portfolios.

Key Takeaways: Alpha vs. Beta vs Smart Beta in Crypto

Implementing advanced traditional finance strategies such as Alpha, Beta, and Smart Beta models in crypto investing can allow for increased control, reduced risks, and effective seizing of opportunities. Let's make a final recap of the strategies analyzed:

Positive Alpha Models: Aiming to Outperform The Market

  • Goal: Alpha models aim to achieve returns that exceed a benchmark index through specific assets or thematic basket picking.
  • Approach: Involves fundamental and technical analysis to select a specific basket of cryptocurrencies.
  • Benefits: Potential for superior returns, customization to specific market segments or themes, and flexibility to adapt to market changes.
  • Risks: Requires significant knowledge of market data, trends, and dynamics, with higher potential for both gains and losses.
  • Example: Focusing on a specific crypto basket such as the RWA (Real-World Assets) CTI to outperform a Top 10 Crypto Index.

Negative Beta Models: Higher Stability and Sound Risk Management

  • Goal: Beta models seek to replicate the performance of a benchmark index, focusing on higher stability and risk reduction.
  • Approach: Passive investment strategy aiming for predictable returns that align with the broader market.
  • Benefits: Lower volatility, reduced investment costs, and suitability for conservative investors seeking stable returns.
  • Risks: Limited potential for outperforming the market, with returns closely tied to the benchmark's performance.
  • Example: A Digital Inflation Hedge CTI combining Bitcoin, Pax Gold, and USD Coin to reduce volatility compared to Bitcoin alone.

Smart Beta Models: Systematic and Enhanced Investing

  • Goal: Smart Beta models aim to outperform indices' benchmarks using systematic, rule-based approaches while improving diversification and managing risks.
  • Approach: Employs alternative weighting and rebalancing methods based on factors like value, momentum, quality, and more.
  • Benefits: Enhanced risk-adjusted returns, improved diversification, transparency, and reduced need for manual intervention.
  • Risks: Requires careful selection of predefined factors and systematic rebalancing to maintain performance.
  • Example: The Recovery CTI, which selects cryptocurrencies with significant price drops but strong recovery potential, systematically rebalancing based on predefined metrics.

We hope that this analysis has provided you with all the information you need to implement more advanced strategies such as Alpha, Beta, and Smart Beta models in crypto trading. Remember that every investor has different risk tolerance, necessities, goals, budgets, and personal situations. No investment strategy can fit every investor, and you should DYOR (Do your own research) before investing in any financial assets. Additionally, consider that past performances are not predictive of future results, and you should always adopt sound risk management. We invite all the financial institutions and businesses that are interested in creating custom advanced strategies and crypto index funds to contact the Trakx Team and start collaborating together.

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